This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the bottom of any article.

February 14, 2013

PIMCO’s El-Erian: Prepare for More Currency Confusion

What caused the ‘muddle,’ and what should investors do?

“Within the last 24 hours, G-7 officials issued a currency statement, ‘clarified’ it and then criticized the clarification!” Mohamed El-Erian wrote at the Huffington Post on Thursday. The PIMCO boss then goes on the offer three possible reasons for this “muddle,” as well as what it may mean for investors.

The statement issued Wednesday by the G-7 was “a response to increasing global concerns about currency wars,” El-Erian explains. “It stressed that members' policy approach ‘remains oriented toward meeting ... domestic objectives using domestic instruments.’ And to make things totally explicit, officials added that exchange rates are not being ‘targeted.’”

“Some countries, like the U.S., are advocating a broader adoption of ‘reflationary national policies’ around the world. Essentially, they believe that the income effects will dominate the prices effects. Others, such as Germany, worry about the inflationary implications and related financial fragilities of such policies.”

Given all this, he concludes, it is not surprising that the G-7 statement did very little to dampen currency movements.

“I also doubt that the other likely short-term objective—that of pre-empting currency disagreements at Friday's G-20 meeting—will be fully successful.”

For these reasons, he advises investors should:

• "Expect currency volatility to continue,

• Look for policy interest rate convergence to spread throughout the world (read: more emerging economies) as a larger number of central banks succumb to the Fed's approach, and

• Expect equity investors to separate even more into two major camps when it comes to characterizing the future impact of unusual monetary policy activism: between those who have unfaltering blind faith in the effectiveness of central banks, and those who respect central banks but recognize that their policies' are becoming increasingly ineffective and that collateral risks/unintended consequences will mount."